FAR 15.407-4—Should-cost review.
Plain-English Summary
FAR 15.407-4 explains the Government’s "should-cost" review process, which is a specialized cost analysis used to look beyond a contractor’s historical costs and assess whether current operations are economical and efficient. The section covers the general purpose of should-cost reviews, the two types of reviews—program should-cost reviews and overhead should-cost reviews—the circumstances in which each should be considered, the kinds of cost elements each review examines, and the team-based approach used to conduct them. It also addresses when separate audit reports are required, when the contracting officer must document the planned review in the acquisition plan and solicitation, and how findings are used in negotiation. In practice, this section is about finding cost-saving opportunities before award or before establishing forward pricing rates, especially in major system acquisitions, sole-source situations, or other high-dollar, high-impact procurements. It also creates a follow-through obligation: the contracting officer must communicate identified inefficient or uneconomical practices, obtain correction or disposition agreements, and establish a plan to monitor corrective action. For contractors, this means should-cost reviews can directly affect proposed prices, FPRA negotiations, and post-negotiation corrective actions. For Government personnel, it requires coordination among contracting, audit, pricing, engineering, and contract administration staff to produce realistic negotiation objectives and measurable savings recommendations.
Key Rules
Should-cost is not historical-cost
Should-cost reviews do not assume past contractor costs are efficient or economical. Instead, they examine the contractor’s workforce, methods, materials, equipment, real property, operating systems, and management to identify opportunities to reduce contract performance costs.
Two review types exist
The regulation recognizes two forms of should-cost review: program should-cost reviews and overhead should-cost reviews. They may be performed together or separately, depending on the acquisition and the cost issues involved.
Program reviews target direct costs
A program should-cost review focuses on significant direct cost elements, such as labor and material, plus associated indirect costs tied to major systems. When used on a contractor proposal, a separate audit report on the proposal is required.
Program reviews are situational
A program should-cost review should be considered when there is already some production experience, the award is sole source, future production quantities are substantial, costs have been rising, the work is well defined, and the Government has enough time and qualified personnel to conduct the review.
Program findings affect negotiation
The contracting officer must consider the review team’s findings and recommendations when negotiating price. After negotiation, the contracting officer must provide the ACO a report of inefficient or uneconomical practices and any correction or disposition agreements, and must establish a follow-up plan.
Program reviews should be disclosed
If a program should-cost review is planned, the contracting officer should identify that fact in the acquisition plan or updates and in the solicitation. This helps align acquisition strategy, staffing, and contractor expectations.
Overhead reviews target indirect costs
An overhead should-cost review evaluates indirect cost elements such as fringe benefits, shipping and receiving, real property, equipment depreciation, plant maintenance and security, taxes, and G&A expenses. It is normally used to evaluate and negotiate an FPRA.
Site selection is risk-based
When choosing contractor sites for overhead reviews, the Government should consider the amount of Government business, level of participation, amount of noncompetitive work, proposal volume, major system or program activity, reorganizations, mergers, acquisitions, takeovers, and other significant changes.
Overhead findings guide FPRA positions
The overhead review’s objective is to identify inefficient or uneconomical practices and recommend corrective action. The ACO should use the findings as the basis for the Government’s FPRA negotiation position, and must establish a follow-up plan to monitor corrections.
Separate audit reports may be required
A separate audit report is required for a program should-cost review conducted relative to a contractor proposal, and for an overhead should-cost review. If overhead review is done with a program review, a separate overhead report is not required, but the findings still must be provided to the ACO.
Responsibilities
Contracting Officer
Decide whether a should-cost review is appropriate, identify the highest-potential cost-saving areas, ensure the review is reflected in the acquisition plan and solicitation when planned, consider the team’s findings in price negotiations, provide required post-negotiation reports to the ACO, and establish follow-up plans to monitor corrective actions.
Should-Cost Review Team
Conduct a multi-functional analysis of the contractor’s operations, evaluate direct or indirect cost drivers depending on the review type, identify inefficient or uneconomical practices, and prepare the required team report in accordance with agency procedures.
ACO (Administrative Contracting Officer)
Receive the findings and recommendations from the contracting officer, use the information to support FPRA negotiations where applicable, and monitor follow-up actions to ensure identified practices are corrected or dispositioned.
Audit Personnel
Support the review with audit analysis and prepare separate audit reports when required, especially for program reviews tied to proposals and for overhead should-cost reviews.
Pricing Personnel
Assist in evaluating cost elements, quantifying savings opportunities, and translating should-cost findings into realistic negotiation objectives and pricing positions.
Engineering and Technical Personnel
Assess manufacturing processes, equipment, methods, and technical efficiency issues, and help determine where operational changes could reduce cost without harming performance.
Contract Administration Personnel
Provide operational insight into contractor performance, support on-site review efforts, and help track corrective actions after negotiation.
Contractor
Cooperate with the review, provide relevant cost and operational information, and address identified inefficient or uneconomical practices through agreed corrective actions or disposition arrangements.
Practical Implications
Should-cost reviews are most important in high-dollar, sole-source, or repeat-production buys where the Government has leverage to improve future pricing, not just validate past costs.
A common pitfall is treating should-cost like a routine cost analysis; the whole point is to challenge whether the contractor’s current operations are efficient, so the review must be deeper and more operationally focused.
Another frequent issue is failing to plan enough time or staff with the right skills; the regulation specifically expects qualified personnel and adequate time before a review is undertaken.
Contracting officers should not forget the documentation and follow-through requirements: planned reviews should be disclosed, findings must be considered in negotiation, and corrective actions need a monitoring plan.
For overhead reviews, site selection matters. Agencies should focus resources where Government business volume, noncompetitive work, proposal activity, or organizational changes suggest the greatest chance of meaningful savings or rate improvement.
Official Regulatory Text
(a) General. (1) Should-cost reviews are a specialized form of cost analysis. Should-cost reviews differ from traditional evaluation methods because they do not assume that a contractor’s historical costs reflect efficient and economical operation. Instead, these reviews evaluate the economy and efficiency of the contractor’s existing work force, methods, materials, equipment, real property, operating systems, and management. These reviews are accomplished by a multi-functional team of Government contracting, contract administration, pricing, audit, and engineering representatives. The objective of should-cost reviews is to promote both short and long-range improvements in the contractor’s economy and efficiency in order to reduce the cost of performance of Government contracts. In addition, by providing rationale for any recommendations and quantifying their impact on cost, the Government will be better able to develop realistic objectives for negotiation. (2) There are two types of should-cost reviews-program should-cost review (see paragraph (b) of this subsection) and overhead should-cost review (see paragraph (c) of this subsection). These should-cost reviews may be performed together or independently. The scope of a should-cost review can range from a large-scale review examining the contractor’s entire operation (including plant-wide overhead and selected major subcontractors) to a small-scale tailored review examining specific portions of a contractor’s operation. (b) Program should-cost review. (1) A program should-cost review is used to evaluate significant elements of direct costs, such as material and labor, and associated indirect costs, usually associated with the production of major systems. When a program should-cost review is conducted relative to a contractor proposal, a separate audit report on the proposal is required. (2) A program should-cost review should be considered, particularly in the case of a major system acquisition (see part 34 ), when- (i) Some initial production has already taken place; (ii) The contract will be awarded on a sole source basis; (iii) There are future year production requirements for substantial quantities of like items; (iv) The items being acquired have a history of increasing costs; (v) The work is sufficiently defined to permit an effective analysis and major changes are unlikely; (vi) Sufficient time is available to plan and adequately conduct the should-cost review; and (vii) Personnel with the required skills are available or can be assigned for the duration of the should-cost review. (3) The contracting officer should decide which elements of the contractor’s operation have the greatest potential for cost savings and assign the available personnel resources accordingly. The expertise of on-site Government personnel should be used, when appropriate. While the particular elements to be analyzed are a function of the contract work task, elements such as manufacturing, pricing and accounting, management and organization, and subcontract and vendor management are normally reviewed in a should-cost review. (4) In acquisitions for which a program should-cost review is conducted, a separate program should-cost review team report, prepared in accordance with agency procedures, is required. The contracting officer shall consider the findings and recommendations contained in the program should-cost review team report when negotiating the contract price. After completing the negotiation, the contracting officer shall provide the ACO a report of any identified uneconomical or inefficient practices, together with a report of correction or disposition agreements reached with the contractor. The contracting officer shall establish a follow-up plan to monitor the correction of the uneconomical or inefficient practices. (5) When a program should-cost review is planned, the contracting officer should state this fact in the acquisition plan or acquisition plan updates (see subpart 7.1 ) and in the solicitation. (c) Overhead should-cost review. (1) An overhead should- cost review is used to evaluate indirect costs, such as fringe benefits, shipping and receiving, real property, and equipment, depreciation, plant maintenance and security, taxes, and general and administrative activities. It is normally used to evaluate and negotiate an FPRA with the contractor. When an overhead should-cost review is conducted, a separate audit report is required. (2) The following factors should be considered when selecting contractor sites for overhead should-cost reviews: (i) Dollar amount of Government business. (ii) Level of Government participation. (iii) Level of noncompetitive Government contracts. (iv) Volume of proposal activity. (v) Major system or program. (vi) Corporate reorganizations, mergers, acquisitions, or takeovers. (vii) Other conditions ( e.g., changes in accounting systems, management, or business activity). (3) The objective of the overhead should-cost review is to evaluate significant indirect cost elements in-depth, and identify and recommend corrective actions regarding inefficient and uneconomical practices. If it is conducted in conjunction with a program should-cost review, a separate overhead should-cost review report is not required. However, the findings and recommendations of the overhead should-cost team, or any separate overhead should-cost review report, shall be provided to the ACO. The ACO should use this information to form the basis for the Government position in negotiating an FPRA with the contractor. The ACO shall establish a follow-up plan to monitor the correction of the uneconomical or inefficient practices.